Goldman Sachs Is Really Just a Used-Car Dealer, So Don't Complain

Two straight quarters of bungled trading results at Goldman Sachs Group Inc. (GS) have spurred some Wall Street analysts to call for the replacement of CEO Lloyd Blankfein.

Yet one big shareholder says his confidence in the firm's historic trading prowess is unshaken. And the stock, following a plunge in the past few months, now looks even more attractive.

Charles Bobrinskoy, vice chairman of the $12 billion money manager Ariel Investments in Chicago, says that despite the string of "tough quarters" for Goldman's bond, currency and commodity traders, nothing is "fundamentally wrong" with the operations. A former investment banker himself, Bobrinskoy is portfolio manager of the $54 million Ariel Focus Fund, which gained 22% in the year through June 30, beating the benchmark Russell 1000 Value Index by nearly seven percentage points.

"Our thesis is that it's temporary, that Goldman Sachs is still a great trading firm," Bobrinskoy said.

Goldman, which has dazzled investors for decades with its uncanny ability to maneuver markets while producing three U.S. Treasury secretaries, has delivered worst-on-Wall-Street trading results this year.

During the first half of 2016, revenue from trading bonds, currencies and commodities like crude oil and gold tumbled 21% from a year earlier, even as uptown rival Morgan Stanley (MS) saw a gain of 36%. Citigroup Inc.'s (C) fixed-income revenue climbed by 5.5% and Bank of America Corp.'s (BAC) rose by 1.1%. JPMorgan Chase & Co.'s (JPM) revenue from the business slipped by 1.7%.

On a conference call, chagrined Goldman executives vowed to review the trading unit to identify areas for potential improvement. They explained the dismal performance by pointing to the unusual calm prevailing over markets that led to subdued customer orders. They also pointed out that the firm's commodities-trading arm is bigger than those of rivals, putting it at a disadvantage during a period when oil markets were in a funk.

Ariel's Bobrinskoy buys Goldman's explanation that the firm is more heavily skewed toward commodities than rivals. What he doesn't buy is that the results are mainly a function of customer trading volumes; the bigger determinant is where prices go, since Wall Street dealers typically have significant holdings in assets that rise and fall along with their particular markets.

The dynamic is akin to the operations of a used-car dealer, according to Bobrinskoy. When used-car prices are stable, dealers profit by pocketing the markups on their sales; when used-car prices are falling, dealers lose money on their inventory.

So the 9% slide in crude-oil prices during the second quarter helps explain why Goldman's trading business underperformed, especially during a period when the fixed-income and foreign-exchange markets were also sluggish.

"This is one thing that people don't understand about trading," Bobrinskoy said. "They think of it as revenue generated by customer activity, when in fact a lot of it is positioning and what you own."

Richard Bove, an analyst at Rafferty Capital, said Goldman suffers from an overreliance on trading and investment-banking revenue -- a business model that he argues became obsolete following the 2008 financial crisis that felled rival Wall Street firms Bear Stearns, Lehman Brothers and Merrill Lynch.

Over the past decade, Goldman's stock price has risen just 16%, while industry leader JPMorgan Chase & Co. has doubled and the Standard & Poor's 500 Index of large U.S. stocks is up 70%.

"The core problem with Goldman is that it made the decision in 2006 and 2007 that this would be a momentary adjustment," Bove said in an interview. "They need a whole new management team, major changes on the board of directors, and they need to redevelop their business model."

A Goldman spokesman declined to comment.

According to Bobrinskoy, investors are overreacting. The 148-year-old firm's stock is down 6.8% this year, and Bobrinskoy thinks it now looks favorably priced. He sold his holdings in Morgan Stanley earlier this year following a runup in that firm's shares, he said. But he hung onto his Goldman shares -- about $5 million worth - and plans to keep them and possibly buy more.

The stock is trading at about 11.4 times the next 12 months' earnings, versus 12.8 times for JPMorgan and 12.6 times for Morgan Stanley, according to FactSet. And while many investors have scaled back their expectations of big tax cuts and a rollback of regulations under President Donald Trump, Bobrinskoy said he believes the proposed measures will eventually become a reality.

The stock is "very attractively priced, and all the bullish arguments after the election are still valid," he said.

In other words, the used-car business will turn around eventually.

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